After more than a decade of lean startup revolution, I had thought that defensibility is a topic that most modern entrepreneurs, if not all, are familiar with. However, increasingly I'm running into entrepreneurs who are familiar with all the keywords such as growth hacking, cap, iteration, pivot or even scalability, but not very clear about defensibility.
This is quite unfortunate since scalability and defensibility are the two most important factors for VCs when evaluating investment opportunities. Any new business can be a good business, but only those that are both scalable and defensible are VC-fundable, due to the high-risk/high-expected-return nature of VC capital.
I thought I take the chance to recap the several main forms of defensibility and their effectiveness in today's venture environment. Note that they apply to both software and hardware startups. In fact, it's imperative that today's hardware startups take a page out of the lean game to be successful. The 90's are long gone.
Apparently you can't copy what you don't know. Secrecy is probably the oldest defensibility of businesses against competitors (and copycats) in the history of mankind. A notable modern example would be Coca Cola and its secret receipe, although it's probably more marketing than real differentiator given that most blind tastes show that consumers couldn't really tell Coca from Pepsi.
In terms of modern startups, secrecy is not the best policy in most cases since the startups have to explain their products or services to their users at some point. Especially in the case of lean startups, where copying is relatively easy, secrecy is really not a defensibility per se. A startup has to rely on execution – running faster than its copycats – to defend itself.
That said, as of today we do have a couple of notable hardware startups that employ secrecy as their defensive schemes.
Magic Leap is notoriously secretive. While Oculus VR built its rise to acquisition by Facebook almost entirely under the sun, no one outside of Magic Leap – except its investors which famously include Andreesen Horowitz, KPCB, Google and Qualcomm Ventures – has had the chance to try out their AR technology. Considering that their potential exit is probably acquisition by Google, which is already their largest shareholder, this secrecy probably makes sense since they can roll out the products after that eventual exit and under the Google umbrella.
Another famous hardware startup that seems to defend itself through secrecy is uBeam, which claimed to have developped a technology that can remotely charge a device using ultrasounds. Likewise, outside of its famous investors that include Marissa Mayer, Mark Cuban and Andreesen Horowitz (again!), not many people have ever seen a working prototype in real life. Now as an analog engineer for more than a decade in my previous career, it's for me hard to believe that one could achieve a reasonable efficiency (and device sizes) in wireless charging, whatever forms it is. Then again, I've never seen the prototype (and the mathematical explanation of the physics behind it) so I can't really judge whether it's me that's being stupid. I can only sincerely hope that when one day they finally will roll out the services in Starbucks, they will be able to instantly convince their consumers that its technology has negligible effect on human health. (Remember how long it took before people believe that cellphone EM waves are not harmful?
These days when I see a page in the pitch deck that talks about patents, I skip to the next page immediately.
Today patent litigation is a war, not a one-to-one mortal combat. You need not just one or two patents, but a whole arsenal to be able to participate in the war. It's definitely not a game for startups. When I left Qualcomm in 2012, we had claimed more than 300 patents for 4G LTE alone. Samsung claimed similiar amount of patents. It's an arms race, much like Cold War between USA and USSR. In this kind of war, bringing a single bazooka to the battelfield, however advanced it is, is not only meaningless, but sometimes could be lethal as is the case of the famous turn of fortune for SiRF, a once highly successful GPS chip company.
In addition, to get a patent approved takes 1~3 years. To sue your copycat and win the case will take another 2~3 years. That's 6 years in total without considering any complication. The most successful startups will already be preparing its IPO in 6 years. No monetary reward coming out of the end of that long tunnel is worth the wait. Not to mention that lawyers are expensive.
Now assuming that technology is at the core of a startup's competitive advantage today, what should it do then? Well, instead of getting a patent, pay the annual fees to USTPO and pretend that one would be able to make money out of it someday, a startup can always file for provisionary patents. This would set up a very effective prior art and at least prevent copycats, startups or corporates, from trying to bite you with your own teeth.
In general, the speed of the startup world is so fast these days that it's really not a good idea to spend a lot of effort with the patent lawyers trying to get a patent approved or win a meaningless litigation. Instead, one should focus on execution of the business strategies and building up other defensibilities, as described below.
Switching cost is probably the most hated but also the most effective defensibility. The Nikon-vs-Canon battle is the most famous one: a long-time Nikon user has to sell all his F-mount lenses at various discounts to be able to switch to Canon, and vice versa.
However even for startups it's not any news. People complain about Dropbox but they don't really switch since it's too troublesome to download all their cloud files and upload them again to other cheaper or better platforms. All photo hosting services that have enjoyed some sort of success, such as Flickr, Smugmug or Zenfolio, have that as well since it's really painful to rebuild galleries and directories. As long as the service is passable compared to the price, people will stick with it. In my case, after years of being a royal paying user for Zenfolio, it took a very slow site development for almost 1.5 years on their side for me eventually to decide to bite the bullet and switch to Smugmug.
And Youtube would be a great example as well. However convenient the Facebook videos have become, for heavy video uploaders it really doesn't make sense to re-upload all the videos to Facebook again. The switching cost here includes all the historical "likes" and "subscribed" you would lose by switching to Facebook – how could you claim to be one of the youtube wunderkids if you have to restart your like count at 0?
User Experience (UX)
This has become the buzzword in startups since the lean movement. However, it's also not new.
As early as in the 19th Century, Le Bon Marché Rive Gauche in Paris started hiring young ladies, dressing them in beautiful uniforms and training them on interacting with the customers. The overall shopping experience in this oldest department store in the world has remained unparalleled until today, so much so that it's still commanding a premium pricing on everything it sells in store, despite the fact that you could find some of those products easily and more cheaply in the more tourist-aware rivals such as Le Printemps and Galeries Lafayette.
A modern example would be Apple, which reigns supreme in UX. One can find the same functionalities in all other smartphones or laptops, but the overall UX in Apple products is so good that it takes only a short time for most people to get used to it and become addicted. In my case, after being a PC user for more than 20 years, it took me only one weekend at home to completely become a Mac OS fan after I acquired my first Macbook (an Air!) in 2010.
For lean startups, UX is even more important. This is because function-wise every lean idea will have probably 20 – or 200 if you are in China – startups offering more or less the same thing. Only those that have the best UX would catch on. Case in point would be Slack, which launched itself into exposive growth via superior (and more fun) UX despite many precendents in the field of enterprise messaging platforms.
Note that today UX is not really a differentiator, but a must for startups. There's no excuse for not spending the time and resource on this one, really.
This is the ultimate defensibility. This reigns over any other. In almost all the most successful modern startups, you can find this element, if it's not the core element of their successes.
Basically network effect means "the more people using a service/product, the more useful/attractive the service/product will be".
This is also not a new invention. The early stage of telephone network was exactly like this. When there were only 20 adoptors in town, it was not very attractive given the high price and few contacts you could get to. However, once it reaches a certain critical mass, it would suddenly become a very attractive solution and will only become more and more attractive.
The most successful on-line marketplaces have enjoyed the same effect, such as early winners eBay, Rakuten and Taobao, as recent as in Airbnb. They bridge the vendors and the buyers. The more the quality vendors on the platform, the more the buyers will go to the platform to look for offerings. The more buyers go to the platform, the more the vendors will be attracted to list their items there.
In the kind of market driven naturally by network effect, the first one that executes to scale will win it all. This was exactly the case when Google+ rolled out trying to overtake Facebook with its much better UX – it was a war waiting to be lost. As much complaint as FB users have on UX, FB had already won! It has the most users in its network, which is what's core to social network.
The same could be used to explain why in messaging apps we see strong divides across different countries. In Japan, Taiwan and some countries in SEA, the Japanese LINE had executed the fastest despite its awful app performance. WeChat monopolized China before Whatsapp even got in. Kakaotalk has more than 90% market share in South Korea. Once these network advantages were established, it was pretty much game over. However much money or functional advantage Whatsapp (claim) to have, it won't be able to break into those markets.
Network effect is so effective that today if I see a hardware startup having the chance to build a certain network effect – think about Fitbit and its users competing against each other for steps walked per day – I am more than happy to ignore other visible deficits of the founders, such as wearing a yellow jacket walking on the streets of Paris.
Coz' I know my investment will have a higher chance to be successful with them.